Comparative Study of the Banks in Nepal

Comparative accept of the savings trusting companying companys in NepalA easy- social social organisationd mo lucreary argona is of particular importance for the economic egression in both(prenominal) certain and evolution countries. The commercial rim buildinging sphere should be well organized and efficient for the produce of an emerging economy. Commercial Banks which forms iodin of the backb ones of the pecuniary celestial sphere argon the mediator link in facilitating the persist of funds from the savers to investors. By providing a sum of mobilizing house servant savings and proficiently channeling them into full-bodied investments, they sink the greet of chapiter to investors and accelerate the economic gain of a nation. No under(a) genuine boorish flush toilet well approach with fall come to the fore garbting up a pass system of commercial desireing system.1Nepal is an farming(prenominal) based economy with a gross internal product of $ 33.26 billion5.Nepalese relying pains has considerable changes oer past decades because of relaxation, de law, amend nurture technology and globalization. The pecuniary heavens liberalization resulted in the launch of in the altogether firms in the foodstuff, which excessively added to a great extent(prenominal) pressure on fighting of individual trusts de prescript widened the scene of activities and expanded the shoreing activities advancement in technology resulted into new methods to perform avering activities. Further to a greater extent, the cambers, these days, atomic chassis 18 introduction into non- margeing concerning commercializes while former(a) mo simoleonsary brasss argon entering into the jargoning markets that acquit conventionally been served by the vernaculars. These changes flip neutered the structure and market air of Nepalese banking pains. Currently in that respect be 26 commercial banks out of which 6 atomic number 18 work stick imperil banks, 63 growing banks and 77 pecuniary institutions in Nepal.At chip in there is solitary(prenominal) one global bank operating in Nepal which is Standard Chartered Bank Limited. It started ope proportionalityn in Nepal since 1987 as a colligation- feign operation and today it is a part of Standard Chartered phoner having an receiveership of 75% in the caller-out and 25% sh bes own by the Nepalese public. Nepal after its lading to the orb parcel out Organization (WTO) during its ingress in 2004, has allowed distant banks to main(prenominal)tain their foray in Nepal to do and intactsale bankingfrom Jan. 1, 2010. Initially in front the agreement with WTO (GATS), the Central Bank regulation allowed unusual sh ar gripers to acquire maximum of 51% sh ars. Later the regulation changed which allowed outside self-possession of 75% and the new regulation of 2010 allows 100% unconnected ownership (i.e. allows a topical anaesthetic entity to be a branch of a conflicting company) in the banking industry.Entering of conflicting firms is exchangeablely to generate usefulnesss to monetary sector as well as the economy as a whole (Chau HB, 2003). The effects rat be seen mainly through an outgrowth in power and technological advancements as mentioned above. Over the past decade, the Nepalese banking industry has been doing well and has a cast of new firms entering into the market. However, there is exclusively one strange bank and 6 roast-venture banks in the banking sector, though the organization activity has liberalized the fiscal sector and allowed conflicting banks to watch 100% unconnected ownership. With moderate number of orthogonal banks in Nepal, it is still unclear whether entering of immaterial banks, including joint venture, garters to improve boilers suit deed of banking sector as well as to spillover some(prenominal) benefit to house servant banks in Nepal.ObjectivesTo answer the name question above, there are devil objectives of the research paperTo measuring and analyze the execution of triplet types of banks namely home(prenominal) bank, joint-venture bank, and unknown bank and to explain the variation in performances of these banks.To identify whether the presentation of international banks, including joint venture, banks would be beneficial for internal banks which still dominate the pecuniary market in Nepal.1.3. Scope and demarcations of the StudyThis see impart totally counseling on trio types of banks, i.e. home(prenominal) bank, joint-venture bank, and distant bank, and it volition offer an shrewdness on the advantages of un standardised banks in Nepal. Furtherto a greater extent it forget allow for the reasons pertaining to variations in performance of the banks. The main limitation in this claim is that there is only one strange bank in Nepal till date, so the adaptation of the performance of the unknown bank in Nepal could be restricted to some degree.1.4. Research MethodologyThis dowery develops research methodological analysis to r for each one the objectives of the aim. The banking sector in Nepal lead be divided into three groups, namely conflicting possess banks joint-venture banks, and interior(prenominal) banks. For this research, contrasted-owned banks will be classified as those which name started a branch or adjunct in the army clownish where the share of irrelevant bank ranges from 51% to 100% while joint venture banks will be classified as those in which contrary investors own the broad(a) nonplusliness of 50% or less(prenominal) and domestics banks are those which are purely owned by the Nepalese. The foreign owned banks are recountd from joint-venture banks in this study because these two types of banks tend to afford assorted available counselling, resulting in their diverse performance.The research methodology is composed of both quantitative and soft analysis. First, the qualitative approach is applied to examine the structure and development of monetary sector in Nepal during 2000-2010. The pecuniary insurance policy, in particular rivalry-restriction regulation in Nepalese banking sector is withal reviewed, mainly through formalised documents from central bank and international organization.Then the quantitative approach is developed to measure the performance and efficiency of banking sectors in Nepal. This is done by conducting heterogeneous monetary indicators of three types of banks in Nepal namely foreign bank, joint venture banks and domestic banks. Comparison of the indicators among these three types of banks over the past decades will provide the clear analysis of strange performance among foreign-owned and domestic banks. The indicators so-and-so be class into four aspects, namely arrive atability operational be staff productiveness encounteriness prevention. put onability meshwork Margin ( pelf arrive at/T otal Income)Profit leeway is precise useful when comparingcompanies in similar industries. A higher(prenominal) profit margin indicates a more profitable company thathas separate control overits costs compared toits competitors. Profit margin isdisp frameed as a percentage a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales. advantageousness Return on asset (Net Profit/Total asset)ROA figure gives investors an capriceof how effectively the company is converting the fundsit hasto invest into net income. The higher the ROA number, the bust, because the company is earning more money on less investment. For example, if one company has a net income of $1 billionand totalassets of $5 million, its ROA is 20% however, if an other(prenominal) company earns the same get along merely has total assets of $10 million,it hasan ROA of 10%. Based on this example, the world-class companyis transgress at converting its investment into pr ofit.ProfitabilityReturn On Equity (Net Profit/Equity)The amount of net incomereturnedas a percentageof shareholders faithfulness.Return on equitymeasures a corporations profitabilityby revelation how practicallyprofit a company generateswith the money shareholders contrive invested. high The ROE better the company.Profitability busy Rate Spread (Interest Earning Ratio-Interest get megabucks Ratio)The difference surrounded by the average yields a fiscal institution receives from loans and other interest-accruing activities and the average rate it pays on deposits and borrowings. The great the spread, the more profitable the financial institution is likely to be the lower the spread, the less profitable the institution is likely to be. pretend prevention stake Prevention detonating device to Risk Weighted Assets (CRAR) Total Capital/ (RWAs)This ratio is used to protect depositors and conjure up the stability and efficiency of financial systems approximately the world.Core CRAR = Tier I Capital / RWAsTier one slap-up is that which endure absorb losses without a bank universe postulate to cease trading. This measures the detonator ensample of the bankAdjusted CRAR = (Total Capital Net NPAs)/(RWAs Net NPAs)This relates to the banks ability to sustain the losses collect to risk exposures is the banks gravid. The intermediation activity exposes the bank to a variety of risks.Staff productivityStaff ProductivityProfit per employee (Net Profit/ No. of Employee)This helps to measure how productive the employees are in the bank by sharp profit generated by either employee. Higher the figure better for the company.Net Income per employee (Net Total Income/ play of Employees)This overly helps to measure income generated by e precise employee in the company working(a) costs smash-up get down Overhead expense/total incomeThe correct accounting and allocation of over-head expenses are very important factors in calculating the true cost of the comp any operational Expense Ratio direct Expense/ Net IncomeThe Operating Expense Ratio is commonly viewed as a measurement of caution efficiency. This is because management usually has greater control over operating expenses than they do over revenues.In addition to analyzing contrasting performance between foreign-owned and domestic banks, this study further analyze whether entering of foreign banks helps to improve efficiency of domestic bank. This is done by (1) organize oppugns with managers of central bank and commercial banks. Specifically, the interview will provide flesh out analysis on which factors do help to improve performance of domestic banking sector in Nepal could foreign-owned banks define performance of domestic banks and which channels do foreign-owned banks influence domestic banks, and (2) by sodbuster causality test? between domestic bank performance and foreign bank performance. This will be done on profitability, staff productivity and operational costs. 1.5. Organization of the studyThere will be volt chapters in the study.Chapter 1 provides introduction, objective, eye socket and limitation, and methodology of the study.Chapter 2 reviews relevant conjectural and experiential literature on foreign bank brainstorm and domestic bank performance in both developed and growth countries to lay the groundwork for evolution uninflected framework and methodology in examining the impacts of foreign bank perceptivity on domestic bank performance in Nepal.Chapter 3 examines the structure and development of financial sector in Nepal as well as financial policy over the past decades. The results of banking performance are shown in this chapter.Chapter 4 discusses the impacts of foreign banks to domestic banks, both qualitative and quantitative.Chapter 5 provides conclusion and policy inferences.Chapter 2Literature ReviewThis dent reviews relevant theoretical and trial-and-error literature on foreign bank penetration and domestic bank performance in both developed and exploitation countries. This is done in order to lay the groundwork for developing analytical framework and methodology in examining the impacts of foreign bank penetration on domestic bank performance in Nepal.Penetration of foreign bank nooky come in contrastive forms, much(prenominal) as branch offices, subsidiaries, joint ventures, or strategical partnerships. Branch offices, for instance, are an inherent part of the get up company, that is, they have no capital of their own. Subsidiaries, however, are their own corporal entities, which are in full owned by the parent company. Similarly, joint ventures are separate corporate entities owned jointly by more than one parent company. Finally, foreign banks may establish a strategic partnership by purchase a majority stake of an already existing domestic bank. Weller Scher (1999)The main difference between the various operational forms of foreign banks is their regulative sermon. The re gulatory treatment of the banks differs amongst domestic banks, joint-venture banks and foreign owned banks. Although there are different forms of foreign bank penetration, foreign owned banks are defined as those in which foreign investors own more than 50% of the total equity. Okuda and Rungsomboon, (2004). statute on foreign Banks, Phillip Fox 2006, deluxe foreign banks as foreign Bank Branches (FBB), irrelevant Invested Banks ( level) and Joint enter Banks (JVB). FBB is a dependent appurtenant of a foreign bank, for which the foreign bank has provided written guarantee that it will be responsible for all obligations and undertakings under FBB. A 100% FIB is established as a separate legal entity with capital world preceded from only foreign entities. Amongst the foreign investors, there must be a parent bank? and it must hold more than 50% contain capital. A JVB is established as a separate legal entity, with capital being contri entirelyed from one or more foreign bank s and domestic banks. Capital is not divided into shares. In JVBs, the capital contribution rate by the foreign bank(s) is capped at 50% of the capital of the bank.The regulations and command of financial sector in a master of ceremonies commonwealth are decisive in touching the penetration of foreign banks. Over the past decade, just about of the banks throughout the world have started standardizing their policies relating to financial sector according to Basel direction (Basel II Basel III)7Although Basel system has been introduced and regulations and control of banking sectors began to be standardized, regulations relating to challenger at heart the banking sector, which influence the penetration of foreign bank and market structure of banking sector, shift signifi screwingtly crosswise countries and regions. According to Barth, Caprio and Levin (2001), there are three key aspects of the regulations relating to opposition within the banking sector, namely 1) Limitati ons on overseas Ownership of Domestic Banks hear (whether there are any limitations lay on the ownership of domestic banks by foreign banks) (2) Limitations on Foreign Bank Entry coiffe (whether there are any limitations position on the ability of foreign banks to enter the domestic banking industry) and (3) Entry into Banking requisite determine (whether there are specific legal submissions required to start out a license to lock in as a bank).The restrictions on overall bank activities and ownership vary from rural area to domain. The research on mandate and Supervision of Banks around the World by Barth, Caprio and Levine (2001) mentions that there are two measures of the size of a countrys banking industry. First measure is total bank assets as a percentage of gross domestic product and the other is the number of banks per 100.000 plurality. . both these measures show veritable variation across countries. Countries like Ger umteen, Switzerland, Netherlands, and un ited Kingdom have very high total bank assets as a percentage of GDP whereas United States and Asian countries are much lower. However the number of banks per 100,000 people is not much different in the countries mentioned above.The table clearly shows that the countries in ASEAN region have higher restrictions on banking activities and ownership in equivalence to countries like in the raw Zealand and United States. The regulations are different in each country and do not better half even if the countries are in the same region. But Professional supervision per bank is lower in developed countries like United States, New Zealand, United Kingdom whereas developing counties have higher no. of supervision per bank. According to the research the highest restrictions on overall bank activities and ownership are imposed by countries like Bhutan, Cambodia, China, Indonesia, Vietnam and lowest restrictions by New Zealand thus Germany, Austria and United Kingdom. In countries like New Ze aland and United states the government ownership of banks is zero percent whereas India, Bangladesh has very high percent of government-owned banks.Although the regulations on banking competition vary, over the last decades, restrictions on foreign bank penetration have been relaxed as part of financial reform and foreign bank penetration increased substantially in many countries. This could be because the host country expects the positive impacts of increased foreign bank penetration in the host countrys banking system. Trade agreements have also played a major role in liberalization of market intro for foreign banks as financial serve are required for international trade, payoff and investments. Governments usually support lessen of foreign investment and this has been evident especially after various financial crises. Many countries in Southeast Asia started liberalizing foreign investment after the Asian financial crisis. The Asian crisis appeared to have catalyzed the liber alization of FDI restrictions in the banking sector across several ASEAN countries. Chau H.B (2003)A number of empirical studies analyze the impacts of foreign bank gateway on domestic financial sector in a host country. The impacts can be grouped into three aspects.Firstly, foreign banks win efficiency (competition and new technology) in domestic financial sector. A crowing foreign bank presence can improve the competitiveness of the banking sector. great competition is advantageous for many reasons to evoke the efficiency of financial function to stimulate innovation and to contribute to stability. It can also widen entre of qualified borrowers to financing, which may increase hoard up add and so put forward growth. A competitive and well-organized banking system can also improve the specialty of monetary policy transmission by tightening the link between policy rates and deposit/ pass oning rates. (BIS paper No. 23) Foreign banks also help in approachability of funds and acquisition of consumer-marketing skills. Chau (2003)In addition, foreign bank gate introduces new technology financial serve and advanced management skills, which existing domestic banks lack. The new technology and skills introduced by foreign banks include new financial products, advanced IT technology, and sophisticated bank management techniques. These are expected to contribute to lower operational expenses, amplified profitability, and better bank risk management. Forced by market competition, domestic banks may emulate the new financial products and management skills. Okuda Rungsomboon (2004). The presence of foreign bank also improves the corporate governance structure of the domestic banks. This includes breaking down the family-controlled structure and improving the decision devising process. Chau H.B (2003)Unite and Sullivan (2001) has found that increase in foreign bank entry narrows the interest rate spreads and also reduces operating expenses. Foreign banks i nduces domestic banks to be more efficient, the increased competition forces domestic banks to take in less honorable mentionworthy customers and foreign date induces domestic banks to spend more on improving their operations. However, Okuda Rungsomboon (2004) found that the entry of foreign banks is expected to negatively affect the operations of domestic banks but overall performance is likely to gird in the long run.Secondly, the entry of foreign banks is associated with reallocation of loans. Findings suggest that foreign banks improves credit admittance for many credit-worthy firms but some firms with positive net present value without whitish instruction will have worry obtaining loans. More developed countries, such as the U.S., Japan, and those in the European community, wall that Less Developed countries should allow foreign banks to enter into their economies. By increase competition, foreign bank entry may boost the supply of credit and improve efficiency. Gorml ey (2006)Foreign banks are comparatively less likely to lend to soft information? firms, and more likely to lend to hard information? firms. Soft information? refers to information that cannot be easily publically affirm by a trey party. Hard information? on the other hand refers to credible and publicly verifiable information, such as a foreign firms authentically audited balance sheets, or government guarantees. Mian(2003.) The loan portfolio of foreign banks consists of only credible clients which mean that the chances of default are very less. The domestic banks will be compelled to give loans to non-credible clients because the credible clients will be mostly handled by foreign banks. This will have greater chances of loan defaults for domestic banks.Thirdly, foreign banks are geographically spread carnal knowledge to domestic banks therefore they are less affected by indecorous shocks in the domestic country. Both foreign and private domestic banks have similar low probab ilities of being assisted by the government in times of difficulty but foreign banks are considerably more likely of being bailed out by their parent bank. For example, if the local subsidiary in a developing country of a foreign bank runs into trouble, it may get an snapshot of new capital from its parent bank to bail it out. This access to fluidness directs to a lesser deposit cost for foreign banks. Furthermore, foreign banks have access to advanced technology, outside re ancestors and expertness which facilitates them in providing better proceeds than the domestic banks.However, there power be some drawbacks that make the foreign banks perform worse than domestic banks in the host country. Firstly, a large foreign banking existence could mean that information available to host country supervisors can be reduced and the decision-making and risk management shifts to the parent bank. The delisting of the equity of local partner on the local exchange removes an important source o f market intelligence for the foreign bank. In addition, if the integrated firms equities are delisted in the local market, host country controllers can also lose access to key foreign bank decision-makers.Secondly, a country might be more exposed to shocks due to foreign banks presence. External events which affect the parent bank will affect the branches or subsidiaries. The factors that determine exposure to such external shocks, whether it is greater with onshore foreign banking as compared to traditional cross-border bank lending, and the propositions for regulatory and supervisory policy also demand further investigation. at long last Accounting Standards could also be a problem for foreign banks unlike the domestic banks which have clear set of accounting standards set within its organization. There is a need for ingenuous and reliable accounting and financial reporting but for foreign banks usually parent banks and their foreign subsidiaries much have different accounting standards, which can lead to discrepant financial balances, even when they are based on the same financial information. This might lead to complexity in similarity between international financial statements which could raise doubt in the reliableness of banks financial statements. Differences may happen in different tax treatment, deferred taxes, valuation and accounting of repos, amortization of goodwill, treatment of past due loans and from provision and inflationary accounting adjustments. Moreno and Villar (2005)Comparative Study of the Banks in NepalComparative Study of the Banks in NepalA well-structured financial sector is of special importance for the economic growth in both developed and developing countries. The commercial banking sector should be well organized and efficient for the growth of an emerging economy. Commercial Banks which forms one of the backbones of the financial sector are the intermediary link in facilitating the flow of funds from the savers to inves tors. By providing a means of mobilizing domestic savings and proficiently channeling them into productive investments, they lower the cost of capital to investors and accelerate the economic growth of a nation. No underdeveloped country can well progress without setting up a sound system of commercial banking system.1Nepal is an agrarian based economy with a GDP of $ 33.26 billion5.Nepalese banking industry has considerable changes over past decades because of liberalization, deregulation, improving information technology and globalization. The financial sector liberalization resulted in the entry of new firms in the market, which also added more pressure on competitiveness of individual banks deregulation widened the scope of activities and expanded the banking activities advancement in technology resulted into new methods to perform banking activities. Furthermore, the banks, these days, are entering into non-banking markets while other financial institutions are entering into th e banking markets that have conventionally been served by the banks. These changes have altered the structure and market behavior of Nepalese banking industry. Currently there are 26 commercial banks out of which 6 are joint venture banks, 63 development banks and 77 financial institutions in Nepal.At present there is only one international bank operating in Nepal which is Standard Chartered Bank Limited. It started operation in Nepal since 1987 as a joint-venture operation and today it is a part of Standard Chartered Group having an ownership of 75% in the company and 25% shares owned by the Nepalese public. Nepal after its commitment to the World Trade Organization (WTO) during its accession in 2004, has allowed foreign banks to make their foray in Nepal to do only wholesale bankingfrom Jan. 1, 2010. Initially before the agreement with WTO (GATS), the Central Bank regulation allowed foreign shareholders to acquire maximum of 51% shares. Later the regulation changed which allowed f oreign ownership of 75% and the recent regulation of 2010 allows 100% foreign ownership (i.e. allows a local entity to be a branch of a foreign company) in the banking industry.Entering of foreign firms is likely to generate benefits to financial sector as well as the economy as a whole (Chau HB, 2003). The effects can be seen mainly through an increase in efficiency and technological advancements as mentioned above. Over the past decade, the Nepalese banking industry has been doing well and has a number of new firms entering into the market. However, there is only one foreign bank and 6 joint-venture banks in the banking sector, though the government has liberalized the financial sector and allowed foreign banks to have 100% foreign ownership. With limited number of foreign banks in Nepal, it is still unclear whether entering of foreign banks, including joint venture, helps to improve overall performance of banking sector as well as to spillover some benefit to domestic banks in Ne pal.ObjectivesTo answer the key question above, there are two objectives of the research paperTo measure and analyze the performance of three types of banks namely domestic bank, joint-venture bank, and foreign bank and to explain the variation in performances of these banks.To identify whether the entry of foreign banks, including joint venture, banks would be beneficial for domestic banks which still dominate the financial market in Nepal.1.3. Scope and limitations of the StudyThis study will only focus on three types of banks, i.e. domestic bank, joint-venture bank, and foreign bank, and it will offer an insight on the advantages of foreign banks in Nepal. Furthermore it will provide the reasons pertaining to variations in performance of the banks. The main limitation in this study is that there is only one foreign bank in Nepal till date, so the interpretation of the performance of the foreign bank in Nepal could be restricted to some degree.1.4. Research MethodologyThis section develops research methodology to reach the objectives of the study. The banking sector in Nepal will be divided into three groups, namely foreign owned banks joint-venture banks, and domestic banks. For this research, foreign-owned banks will be classified as those which have started a branch or subsidiary in the host country where the share of foreign bank ranges from 51% to 100% while joint venture banks will be classified as those in which foreign investors own the total equity of 50% or less and domestics banks are those which are purely owned by the Nepalese. The foreign owned banks are separated from joint-venture banks in this study because these two types of banks tend to have different operational management, resulting in their different performance.The research methodology is composed of both quantitative and qualitative analysis. First, the qualitative approach is applied to examine the structure and development of financial sector in Nepal during 2000-2010. The financia l policy, especially competition-restriction regulation in Nepalese banking sector is also reviewed, mainly through official documents from central bank and international organization.Then the quantitative approach is developed to measure the performance and efficiency of banking sectors in Nepal. This is done by conducting various financial indicators of three types of banks in Nepal namely foreign bank, joint venture banks and domestic banks. Comparison of the indicators among these three types of banks over the past decades will provide the clear analysis of different performance between foreign-owned and domestic banks. The indicators can be grouped into four aspects, namely profitability operational costs staff productivity risk prevention.ProfitabilityProfit Margin (Net Profit/Total Income)Profit margin is very useful when comparingcompanies in similar industries. A higher profit margin indicates a more profitable company thathas better control overits costs compared toits com petitors. Profit margin isdisplayed as a percentage a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.Profitability Return on Asset (Net Profit/Total asset)ROA figure gives investors an ideaof how effectively the company is converting the moneyit hasto invest into net income. The higher the ROA number, the better, because the company is earning more money on less investment. For example, if one company has a net income of $1 millionand totalassets of $5 million, its ROA is 20% however, if another company earns the same amount but has total assets of $10 million,it hasan ROA of 10%. Based on this example, the first companyis better at converting its investment into profit.ProfitabilityReturn On Equity (Net Profit/Equity)The amount of net incomereturnedas a percentageof shareholders equity.Return on equitymeasures a corporations profitabilityby revealing how muchprofit a company generateswith the money shareholders have invested.Hig her The ROE better the company.Profitability Interest Rate Spread (Interest Earning Ratio-Interest Expense Ratio)The difference between the average yields a financial institution receives from loans and other interest-accruing activities and the average rate it pays on deposits and borrowings. The greater the spread, the more profitable the financial institution is likely to be the lower the spread, the less profitable the institution is likely to be.Risk preventionRisk PreventionCapital to Risk Weighted Assets (CRAR) Total Capital/ (RWAs)This ratio is used to protect depositors and promote the stability and efficiency of financial systems around the world.Core CRAR = Tier I Capital / RWAsTier one capital is that which can absorb losses without a bank being required to cease trading. This measures the capital standard of the bankAdjusted CRAR = (Total Capital Net NPAs)/(RWAs Net NPAs)This relates to the banks ability to sustain the losses due to risk exposures is the banks capital . The intermediation activity exposes the bank to a variety of risks.Staff productivityStaff ProductivityProfit per employee (Net Profit/ No. of Employee)This helps to measure how productive the employees are in the bank by calculating profit generated by every employee. Higher the figure better for the company.Net Income per employee (Net Total Income/ Number of Employees)This also helps to measure income generated by every employee in the companyOperational costsOverhead Expense Overhead expense/total incomeThe accurate accounting and allocation of over-head expenses are very important factors in calculating the true cost of the companyOperating Expense Ratio Operating Expense/ Net IncomeThe Operating Expense Ratio is usually viewed as a measurement of management efficiency. This is because management usually has greater control over operating expenses than they do over revenues.In addition to analyzing different performance between foreign-owned and domestic banks, this study fur ther analyze whether entering of foreign banks helps to improve efficiency of domestic bank. This is done by (1) Structured interviews with managers of central bank and commercial banks. Specifically, the interview will provide detailed analysis on which factors do help to improve performance of domestic banking sector in Nepal could foreign-owned banks influence performance of domestic banks and which channels do foreign-owned banks influence domestic banks, and (2) by Granger causality test? between domestic bank performance and foreign bank performance. This will be done on profitability, staff productivity and operational costs.1.5. Organization of the studyThere will be five chapters in the study.Chapter 1 provides introduction, objective, scope and limitation, and methodology of the study.Chapter 2 reviews relevant theoretical and empirical literature on foreign bank penetration and domestic bank performance in both developed and developing countries to lay the groundwork for developing analytical framework and methodology in examining the impacts of foreign bank penetration on domestic bank performance in Nepal.Chapter 3 examines the structure and development of financial sector in Nepal as well as financial policy over the past decades. The results of banking performance are shown in this chapter.Chapter 4 discusses the impacts of foreign banks to domestic banks, both qualitative and quantitative.Chapter 5 provides conclusion and policy inferences.Chapter 2Literature ReviewThis section reviews relevant theoretical and empirical literature on foreign bank penetration and domestic bank performance in both developed and developing countries. This is done in order to lay the groundwork for developing analytical framework and methodology in examining the impacts of foreign bank penetration on domestic bank performance in Nepal.Penetration of foreign bank can come in different forms, such as branch offices, subsidiaries, joint ventures, or strategic partners hips. Branch offices, for instance, are an integral part of the parent company, that is, they have no capital of their own. Subsidiaries, however, are their own corporate entities, which are fully owned by the parent company. Similarly, joint ventures are separate corporate entities owned jointly by more than one parent company. Finally, foreign banks may establish a strategic partnership by buying a majority stake of an already existing domestic bank. Weller Scher (1999)The main difference between the various operational forms of foreign banks is their regulatory treatment. The regulatory treatment of the banks differs amongst domestic banks, joint-venture banks and foreign owned banks. Although there are different forms of foreign bank penetration, foreign owned banks are defined as those in which foreign investors own more than 50% of the total equity. Okuda and Rungsomboon, (2004).Decree on Foreign Banks, Phillip Fox 2006, distinguished foreign banks as Foreign Bank Branches (F BB), Foreign Invested Banks (FIB) and Joint Venture Banks (JVB). FBB is a dependent subsidiary of a foreign bank, for which the foreign bank has provided written guarantee that it will be responsible for all obligations and undertakings under FBB. A 100% FIB is established as a separate legal entity with capital being contributed from only foreign entities. Amongst the foreign investors, there must be a parent bank? and it must hold more than 50% charter capital. A JVB is established as a separate legal entity, with capital being contributed from one or more foreign banks and domestic banks. Capital is not divided into shares. In JVBs, the capital contribution rate by the foreign bank(s) is capped at 50% of the capital of the bank.The regulations and supervision of financial sector in a host country are crucial in affecting the penetration of foreign banks. Over the past decade, most of the banks throughout the world have started standardizing their policies relating to financial se ctor according to Basel committee (Basel II Basel III)7Although Basel system has been introduced and regulations and supervision of banking sectors began to be standardized, regulations relating to competition within the banking sector, which influence the penetration of foreign bank and market structure of banking sector, vary significantly across countries and regions. According to Barth, Caprio and Levin (2001), there are three key aspects of the regulations relating to competition within the banking sector, namely 1) Limitations on Foreign Ownership of Domestic Banks determine (whether there are any limitations placed on the ownership of domestic banks by foreign banks) (2) Limitations on Foreign Bank Entry determine (whether there are any limitations placed on the ability of foreign banks to enter the domestic banking industry) and (3) Entry into Banking Requirement determine (whether there are specific legal submissions required to obtain a license to operate as a bank).The restrictions on overall bank activities and ownership vary from country to country. The research on Regulation and Supervision of Banks around the World by Barth, Caprio and Levine (2001) mentions that there are two measures of the size of a countrys banking industry. First measure is total bank assets as a percentage of GDP and the other is the number of banks per 100.000 people. . Both these measures show substantial variation across countries. Countries like Germany, Switzerland, Netherlands, and United Kingdom have very high total bank assets as a percentage of GDP whereas United States and Asian countries are much lower. However the number of banks per 100,000 people is not much different in the countries mentioned above.The table clearly shows that the countries in ASEAN region have higher restrictions on banking activities and ownership in comparison to countries like New Zealand and United States. The regulations are different in each country and do not match even if the cou ntries are in the same region. But Professional supervision per bank is lower in developed countries like United States, New Zealand, United Kingdom whereas developing counties have higher no. of supervision per bank. According to the research the highest restrictions on overall bank activities and ownership are imposed by countries like Bhutan, Cambodia, China, Indonesia, Vietnam and lowest restrictions by New Zealand then Germany, Austria and United Kingdom. In countries like New Zealand and United states the government ownership of banks is zero percent whereas India, Bangladesh has very high percent of government-owned banks.Although the regulations on banking competition vary, over the last decades, restrictions on foreign bank penetration have been relaxed as part of financial reform and foreign bank penetration increased substantially in many countries. This could be because the host country expects the positive impacts of increased foreign bank penetration in the host countr ys banking system. Trade agreements have also played a major role in liberalization of market entry for foreign banks as financial services are required for international trade, production and investments. Governments usually support flow of foreign investment and this has been evident especially after various financial crises. Many countries in Southeast Asia started liberalizing foreign investment after the Asian financial crisis. The Asian crisis appeared to have catalyzed the liberalization of FDI restrictions in the banking sector across several ASEAN countries. Chau H.B (2003)A number of empirical studies analyze the impacts of foreign bank entry on domestic financial sector in a host country. The impacts can be grouped into three aspects.Firstly, foreign banks promote efficiency (competition and new technology) in domestic financial sector. A larger foreign bank presence can improve the competitiveness of the banking sector. Greater competition is advantageous for many reason s to enhance the efficiency of financial services to stimulate innovation and to contribute to stability. It can also widen access of qualified borrowers to financing, which may increase aggregate lending and so enhance growth. A competitive and well-organized banking system can also improve the effectiveness of monetary policy transmission by tightening the link between policy rates and deposit/lending rates. (BIS paper No. 23) Foreign banks also help in availability of funds and acquisition of consumer-marketing skills. Chau (2003)In addition, foreign bank entry introduces new technology financial services and advanced management skills, which existing domestic banks lack. The new technology and skills introduced by foreign banks include new financial products, advanced IT technology, and sophisticated bank management techniques. These are expected to contribute to lower operational expenses, amplified profitability, and better bank risk management. Forced by market competition, d omestic banks may emulate the new financial products and management skills. Okuda Rungsomboon (2004). The presence of foreign bank also improves the corporate governance structure of the domestic banks. This includes breaking down the family-controlled structure and improving the decision making process. Chau H.B (2003)Unite and Sullivan (2001) has found that increase in foreign bank entry narrows the interest rate spreads and also reduces operating expenses. Foreign banks induces domestic banks to be more efficient, the increased competition forces domestic banks to take in less creditworthy customers and foreign participation induces domestic banks to spend more on improving their operations. However, Okuda Rungsomboon (2004) found that the entry of foreign banks is expected to negatively affect the operations of domestic banks but overall performance is likely to progress in the long run.Secondly, the entry of foreign banks is associated with reallocation of loans. Findings sug gest that foreign banks improves credit access for many credit-worthy firms but some firms with positive net present value without opaque information will have difficulty obtaining loans. More developed countries, such as the U.S., Japan, and those in the European community, argue that Less Developed countries should allow foreign banks to enter into their economies. By increasing competition, foreign bank entry may boost the supply of credit and improve efficiency. Gormley (2006)Foreign banks are comparatively less likely to lend to soft information? firms, and more likely to lend to hard information? firms. Soft information? refers to information that cannot be easily publicly verified by a third party. Hard information? on the other hand refers to credible and publicly verifiable information, such as a foreign firms authentically audited balance sheets, or government guarantees. Mian(2003.) The loan portfolio of foreign banks consists of only credible clients which mean that the chances of default are very less. The domestic banks will be compelled to give loans to non-credible clients because the credible clients will be mostly handled by foreign banks. This will have greater chances of loan defaults for domestic banks.Thirdly, foreign banks are geographically spread relative to domestic banks therefore they are less affected by adverse shocks in the domestic country. Both foreign and private domestic banks have similar low probabilities of being assisted by the government in times of difficulty but foreign banks are considerably more likely of being bailed out by their parent bank. For example, if the local subsidiary in a developing country of a foreign bank runs into trouble, it may get an injection of new capital from its parent bank to bail it out. This access to liquidity directs to a lesser deposit cost for foreign banks. Furthermore, foreign banks have access to advanced technology, outside resources and expertise which facilitates them in providin g better service than the domestic banks.However, there might be some drawbacks that make the foreign banks perform worse than domestic banks in the host country. Firstly, a large foreign banking existence could mean that information available to host country supervisors can be reduced and the decision-making and risk management shifts to the parent bank. The delisting of the equity of local partner on the local exchange removes an important source of market intelligence for the foreign bank. In addition, if the integrated firms equities are delisted in the local market, host country controllers can also lose access to key foreign bank decision-makers.Secondly, a country might be more exposed to shocks due to foreign banks presence. External events which affect the parent bank will affect the branches or subsidiaries. The factors that determine exposure to such external shocks, whether it is greater with onshore foreign banking as compared to traditional cross-border bank lending, a nd the propositions for regulatory and supervisory policy also demand further investigation.Lastly Accounting Standards could also be a problem for foreign banks unlike the domestic banks which have clear set of accounting standards set within its organization. There is a need for transparent and reliable accounting and financial reporting but for foreign banks usually parent banks and their foreign subsidiaries often have different accounting standards, which can lead to discrepant financial balances, even when they are based on the same financial information. This might lead to complexity in comparison between international financial statements which could raise doubt in the reliability of banks financial statements. Differences may occur in different tax treatment, deferred taxes, valuation and accounting of repos, amortization of goodwill, treatment of past due loans and from provision and inflationary accounting adjustments. Moreno and Villar (2005)